September 2014

This study investigates the implications of the asymmetric information between managers and shareholders and the resulting costly agency problems. In doing so, it focuses on the heterogeneity of executive directors with respect to their trading behaviour and personal characteristics, and the corporate governance mechanisms which can help lessen the adverse effects of the manager-shareholder agency conflicts. The study recognises that executive directors cannot be treated as a homogenous group and their incentives and the ability to impact decisions differ significantly. Two top executive directors are considered throughout this study, namely Chief Executive Officers (CEOs) and Chief Finance Officers (CFOs).

In this study, we address several important research questions. First, we consider whether executive directors have an informational advantage over outsiders. Second, we address if the heterogeneity of directors with respect to their role in the company and personal characteristics matters. Third, we examine whether internal corporate governance mechanisms play a significant role in moderating the manager-shareholder agency problem. Last but not least, we investigate if the nature of the interactions between asymmetric information, agency issues and corporate governance change during and after the global financial crisis of 2007-08. In carrying out our empirical analysis, we employ a unique dataset on the UK nonfinancial firms during the sample period 2000 to 2010. The detailed information about the corporate governance structure of firms and the personal characteristics of CEOs and CFOs enable us to carry out a comprehensive analysis of the research questions outlined above for three distinct periods, namely the pre-crisis, crisis and post-crisis periods.

Our analysis shows that the position that directors hold in the company and their characteristics can help explain the subsequent market-adjusted returns on insider trading. We find that the returns to insider purchase transactions are generally positive. However, they are weaker in the longer term, possibly suggesting that the informative content of director trades is less significant than it is perceived by the market. The main finding of our analysis in relation to the link between insider trading and the probability of bankruptcy is that insider trading increases the predictive power of insolvency models. This study also reports that CEOs exert a greater influence on the leverage decision than CFOs in firms that seem to operate under their optimal leverage. However, we observe that the CFO’s characteristics become more significant in determining leverage after the recent financial crisis.

Overall, the analysis of this study provides strong evidence for the view that the presence of asymmetric information between insiders and outsiders and the costly manager-shareholder agency conflict are central to our understanding of the corporate finance decision making process and its consequences. However, more importantly, the findings of this study provide a relatively new notion that considering the heterogeneity of top executive directors in the empirical analysis of corporate decisions is essential, especially in exploring modern corporations.